svb asset management economic report q1 2016
TRANSCRIPT
SVB Asset Management | Quarterly Economic Report Q1 2016
Thoughts from the desk 03
Overview 04
Domestic economy 06
U.S. Federal Reserve and monetary policy 12
Markets and performance 18
Global economy 25
Portfolio management strategy 29
Money market fund reform 33
2
Table of contents
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216
Thoughts from the desk
3
Strengthening employment conditions and inflationary readings that are approaching the Fed’s preferred target ranges were overshadowed by global economic uncertainties and continued weakness in commodities. As a result, the Fed maintained its data-dependent stance and kept its benchmark rates unchanged during the first quarter while lowering its interest rate outlook — dampening prospects of their normalization process. Furthermore, other major central banks implemented additional quantitative easing programs, with the Bank of Japan taking the accommodative policy lead by adopting a negative interest rate policy (NIRP). In response, U.S. interest rates pulled back 20-40 basis points across the yield curve as investor preference shifted from risk-on to risk-off trades.
Defensive assets, such as gold and fixed income securities, benefitted from global uncertainties and falling interest rates this quarter. The precious metal surged approximately 16 percent, while the broad fixed income credit market provided returns on par with major U.S. equities — but without the volatility. Volatility did persist throughout the Treasury market this quarter though, and it proved to be a rollercoaster ride for investors. The year began with six weeks of falling interest rates and a 40-basis-point decline in two-year Treasury Note yields. This flipped in the subsequent four weeks, with yields on the same benchmark reclaiming 30 basis points into the March FOMC meeting. And to finish the quarter, the dovish tone of the FOMC sent yields 25 basis points lower.
On the forefront of corporate cash investors’ minds is the upcoming implementation of the next round of Money Market Fund reform in Q4. Investors are weighing the marginal yield benefits of utilizing prime funds as a cash vehicle against the uncertainty of a market-based floating net asset value methodology and tail risk events such as enforcement of a liquidity fee and redemption gates. We continue to stress the importance of executing to our clients’ investment objectives.
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 4
Overview
Fourth quarter 2015 GDP expanded by 1.4 percent. The increase was driven once again by contributions from personal consumption. The increase in GDP for the fourth quarter reflected positive contributions
from consumer spending, residential fixed investment and spending by the federal government. Consumer spending expanded by 2.4 percent in the fourth quarter,
propelled by stronger spending on durable goods and services. Average monthly job gains in Q1 2016 were 209,000. Unemployment rate
is at a healthy level of 5.0 percent, inching up for good reason. More participants entered the labor force, pushing the participation rate
up to 63 percent. Core PCE edged closer to the Fed’s 2 percent target rate at almost 1.7
percent. Despite the strong gain, in a speech to the Economic Club of New York at the end of the first quarter, Chairwoman Yellen said it was “too early to tell if this recent faster pace will prove durable.”
Domestic economy Coming off the first interest rate hike in nearly a decade, Treasury yields fluctuated throughout the quarter as markets assessed the impact of global growth challenges, oil price uncertainty and stronger economic data in the United States. Despite strengthening economic data in the United States, the Fed cited downside risks from global financial and economic developments as the reason for keeping monetary policy unchanged. Inflation has been marching towards the Fed’s 2 percent target; however, it remains unclear if this trend will persist in the medium-term. The Fed continues to stress a “gradual approach” to raising interest rates in light of economic conditions. As such, the Fed’s “dot plot” released in March reflected a lower path of interest rate increases, implying two rate hikes of 0.25 percent in 2016. While the Fed is staying on the sidelines, other central banks across the globe have continued their easing measures in an effort to stimulate growth. The ECB expanded its asset purchase program into corporate bonds, the BOJ joined the ECB in a negative interest rate policy and China once again cut its reserve requirements to improve capital flows.
U.S. Federal Reserve and monetary policy
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 5
Overview
First quarter fixed income returns have improved year-over-year since 2012, as economic fundamentals continue to strengthen and interest rates head directionally higher. Credit spreads on the basic industry sector were the most improved from Q4, as commodity price stabilization reduced broader market volatility. Financial spreads lagged though, as pressure mounted around energy loan portfolios, shrinking capital bases and profitability concerns. While we may be nearing a corporate credit cycle peak, the overall health of corporate credit remains resilient. Most sectors are exhibiting solid credit fundamentals that remain stable, with the exception of energy as it continues to work through the demand and supply imbalance.
Markets and performance Growth is tepid across many regions, as low commodity prices have kindled deflationary worries and created fiscal problems for countries reliant on commodity exports. Major central banks have eased policy already in 2016 to help spur growth and combat falling inflation, with more easing expected as the year progresses. The Federal Reserve is the exception: It is poised to raise interest rates, potentially leading to disruptive currency moves in emerging markets. A devaluation of the Chinese yuan, stemming in part from a stronger U.S. dollar, has contributed to capital outflows over the past year. Low commodity prices, political strife and security challenges, along with a stronger U.S. dollar, are currently confronting emerging markets. Expansion is still largely expected, except for economies heavily reliant on commodity exports.
Global economy
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 7
GDP Consumer continues to fuel economy GDP
Q4 2015 GDP expanded by 1.4 percent. The increase was driven once again by contributions from personal consumption. The increase in GDP for the fourth quarter reflected positive contributions from consumer spending, residential fixed investment and spending by the federal government. Non-residential fixed investment, exports, private inventory investments and state and local government all contributed negatively. Corporate profits fell 11.5 percent on a year-over-year basis. Notably, declines in the profits were concentrated in the petroleum and coal sector, not surprising given the drop in energy prices.
GDP and components
Source: Bureau of Economic Analysis (BEA), Congressional Budget Office (CBO) and SVB Asset Management. Note: GDP values shown in legend are % change vs. prior quarter, on an annualized basis.
-10.0% -8.0% -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0%
U.S. GDP Q-o-Q Trailing 4-quarter average
-3.0%
-1.0%
1.0%
3.0%
5.0%
Government Res investments Inventories Net exports Bus fixed investment Personal consumption exp GDP
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 8
Consumption Cautiously optimistic Consumption overview
Personal consumption continues to benefit from an improved labor market, rising home prices and lower fuel costs. Consumer spending expanded by 2.4 percent in the fourth quarter, propelled by stronger spending on durable goods and services. Retail sales were disappointing in Q1 2016, with January being revised heavily to a 0.4 percent drop. Q1 2016 GDP could be lower due to recent consumer pullbacks. Consumer sentiment continues to stay above 90.0 thanks to more positive personal finances despite a potential slowing economy.
Retail and food service sales Consumer sentiment — University of Michigan
$5.0
$10.0
$15.0
$20.0
$25.0
$250.0
$300.0
$350.0
$400.0
$450.0
$500.0
Vehi
cle
Sal
es (M
illio
ns)
Ret
ail &
Foo
d S
ervi
ces
Sal
es
(Bill
ions
)
Ex Autos Vehicle Sales
$5.0
$10.0
$15.0
$20.0
$25.0
$250.0
$300.0
$350.0
$400.0
$450.0
$500.0
Vehi
cle
Sal
es (M
illio
ns)
Ret
ail &
Foo
d S
ervi
ces
Sal
es
(Bill
ions
)
Ex Autos Vehicle Sales
Ret
ail a
nd fo
od s
ervi
ce s
ales
(b
illio
ns)
Vehi
cle
sale
s (m
illio
ns)
Ex autos Vehicle sales R
etai
l and
food
ser
vice
sal
es
(bill
ions
)
Vehi
cle
sale
s (m
illio
ns)
Ex autos Vehicle sales
Source: Bureau of Economic Analysis (BEA), Congressional Budget Office (CBO) and SVB Asset Management. Note: GDP values shown in legend are % change vs. prior quarter, on an annualized basis.
0.0%
50.0%
100.0%
150.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
Personal consumption (LHS) Personal savings (LHS) Household debt-to-disposable income ratio (RHS) Household debt-to-disposable-income ratio (RHS)
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 9
Employment Chugging along Employment landscape Labor force participation rate
Hires and quits Average monthly job gains in Q1 2016 were 209,000. Unemployment rate is at a healthy level of 5.0 percent, inching up for good reason. More participants entered the labor force, pushing the participation rate up to 63 percent. The hire and quit rates continue to be steady, while job openings climbed; this could be a precursor to future wage pressures. While job growth continues to be strong, wage growth is yet to be seen. Slow wage growth, combined with other global economic concerns could affect the Fed’s desire to raise rates by the second half of the year.
-15.0% -10.0% -5.0% 0.0% 5.0% 10.0% 15.0%
-1,000.0
-500.0
0.0
500.0
1,000.0
Thou
sand
s
Non-Farm Payroll (LHS) Unemployment Rate (RHS) U-6 (RHS)
62.0%
63.0%
64.0%
65.0%
66.0%
67.0%
68.0%
Labor Force Participation Rate (LHS)
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
Job Hire Rate Job Quit Rate
Source: U.S. Bureau of Labor and Statistics (BLS), SVB Asset Management, National Bureau of Economic Research (NBER). Note: The underemployment rate U-6 defined as persons marginally attached to the labor force are those who currently are neither working nor looking for work but indicate they want and are available for a job and have looked for work in the past 12 months.
Nonfarm payroll (LHS) Unemployment rate (RHS)
Job hire rate Job quit rate
Labor force participation rate (LHS)
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 10
U.S. housing Stable Home sales and supply Home prices — indexed to 100
Housing affordability Household formation
0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
Hom
e S
uppl
y (m
onth
s)
Hom
e S
ales
(Mill
ions
)
Total Sales (new & existing) Existing Home Supply
0
50
100
150
200
250
300
Median Home Price FHFA Purchase Case-Schiller 20 City
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
0.0
50.0
100.0
150.0
200.0
250.0
Affo
rdab
ility
Inde
x
Housing Affordability 30 -Year Fixed Mortgage Rates
-3000
-2000
-1000
0
1000
2000
3000
4000
Source: Bloomberg and SVB Asset Management.
Hom
e sa
les
(mill
ions
)
Total sales (new and existing) Existing home supply
Hom
e su
pply
(mon
ths)
Median home price FHFA purchase Case-Schiller 20 city
Affo
rdab
ility
inde
x
Housing affordability 30-year fixed mortgage rates
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 11
Inflation Closer to target Core PCE — % change from prior year Crude oil and gasoline prices
University of Michigan survey of inflation expectations Core PCE is edging closer to the Fed’s 2 percent target rate at almost 1.7 percent. Despite the strong gain, in a speech to the Economic Club of New York at the end of the first quarter, Chairwoman Yellen said it was “too early to tell if this recent faster pace will prove durable.” Oil prices have recovered from lows earlier in the year; however expectations are for oil to remain low for some time. The Fed continues to monitor incoming data carefully as it assesses the timing of the next rate hike.
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
Cha
nge
from
Prio
r Yea
r
Core PCE Fed Target Monetary Policy Threshold
$0.0
$1.0
$2.0
$3.0
$4.0
$5.0
$0.0
$50.0
$100.0
$150.0
Pric
e pe
r bar
rel
Crude Oil (LHS) Daily National Average of Gasoline Prices (RHS)
1.5%
2.5%
3.5%
4.5%
5.5%
1 Year Ahead 5-10 Years Ahead
Source: U.S. Bureau of Labor and Statistics (BLS), SVB Asset Management, National Bureau of Economic Research (NBER). Note: The underemployment rate U-6 defined as persons marginally attached to the labor force are those who currently are neither working nor looking for work but indicate they want and are available for a job and have looked for work in the past 12 months.
Cha
nge
from
prio
r yea
r
Fed target Monetary policy threshold
1 year ahead 5-10 years ahead
Crude oil (LHS) Daily national average of gasoline prices (RHS)
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216
0.00%
0.20%
0.40%
0.60%
0.80%
1.00%
2-Year Treasury Yield 1-Year Treasury Yield
13
Historical interest rates Quarter of volatility
Q2 2015 Q3 2015 Q4 2015 Q1 2016
U.S. economic data reveals some softness as Q1 GDP contracts 0.2 percent.
Anxieties over Greece dissipate early in the quarter, but then concerns over China’s growth and currency devaluation take the spotlight.
The Fed’s tone shifts at the October FOMC meeting, and markets refocus their attention on a December rate hike.
Despite strengthening employment and inflation in the U.S., the Fed refrains from a second rate hike during the quarter as global conditions continue to pose risks.
Headlines center on a potential “Grexit” with a standoff between Greece and its creditors.
The U.S. economic landscape continues to improve: Unemployment drops to 5.1 percent, Q2 GDP expands 3.9 percent and inflation holds at 1.3 percent.
Employment and inflation readings head in the right direction. October’s report was the strongest of the year, and the unemployment rate fell to 5 percent. Core CPI reaches the important 2 percent level. Core PCE stands at 1.3 percent.
Central banks around the world implement additional easing measures with the BOJ adopting a negative interest rate policy, China cutting reserve requirements and the ECB expanding their asset purchase program into the corporate bond market.
Fed hints at rate hike this year, but a gradual path to normalization.
The Fed delayed rate liftoff, citing “recent global economic and financial developments.”
Continued weakness in China and depressed oil prices make headlines throughout the quarter.
After hitting recent lows, oil prices see some stabilization towards quarter-end as world leaders discuss a production freeze.
2-year treasury yield 1-year treasury yield
Source: Bloomberg and SVB Asset Management. Data as of March 31, 2016.
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 14
Tracking key indicators Waiting for stability The dollar and oil Inflation
The labor market China and E.U. markets
0.0
20.0
40.0
60.0
80.0
100.0
120.0
70.0 75.0 80.0 85.0 90.0 95.0
100.0 105.0
DXY Index (LHS) Brent Crude Index (RHS)
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
Core PCE YoY Fed Target
60.0% 61.0% 62.0% 63.0% 64.0% 65.0% 66.0% 67.0%
-1,000.0
-500.0
0.0
500.0
1,000.0
Thou
sand
s
Nonfarm Payrolls (LHS) Labor Force Participation Rate (RHS)
2800
2900
3000
3100
3200
3300
2500
2700
2900
3100
3300
3500
3700
Shanghai Comp (LHS) Euro Stoxx (RHS)
Fed target
Nonfarm payrolls (LHS) Labor force participation rate (RHS)
Source: Bloomberg and SVB Asset Management. Data as of March 31, 2016.
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
Hun
dred
s
15
Federal Reserve rate projections Momentary pause
March 2016 median 0.375% 0.875% 1.875% 3.000% 3.25%
December 2015 median 0.375% 1.375% 2.375% 3.250% 3.50%
September 2015 median 0.375% 1.375% 2.625% 3.375% 3.50%
Source: Bloomberg and Federal Reserve Data as of March 16, 2016. Percentages below the chart reference the median forecasted rate at the end of each period.
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 16
Central bank economic projections Easing up 2015 2016 2017 2018 Longer run
Economic projections: United States
Change in real GDP 2.4% 2.2% 2.1% 2.0% 2.0%
Unemployment rate 5.0% 4.7% 4.6% 4.5% 4.8%
Core PCE inflation 1.3% 1.6% 1.8% 2.0%
Interest rate projections: United States
Federal funds target rate 0.4% 1.4% 2.4% 3.3% 3.5%
Economic projections: Eurozone
Change in real GDP 1.6% 1.4% 1.7% 1.8%
CPI inflation 0.0% 0.1% 1.3% 1.6%
Unemployment rate 10.9% 10.4% 10.2% 9.9%
Economic projections: China
Change in real GDP 6.9%
CPI inflation 1.4%
Unemployment rate 4.1%
Economic projects: Japan
Change in real GDP 0.5% 1.5% 0.3%
CPI inflation 0.8% 0.8% 1.8%
Source: Federal Reserve, European Central Bank, National People’s Congress of China, Bank of Japan. Data as of March 31, 2016. Forecasts are not available for all periods.
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 17
Probability of move Doves pushing back
Historical probabilities of an interest rate hike at each FOMC meeting
Source: Implied probabilities of Fed funds futures, compiled by Bloomberg
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
Dec FOMC Jan FOMC Feb FOMC Mar FOMC
With the Fed raising rates by a quarter of a percentage point in December 2015, markets had high expectations for future rate hikes heading into 2016. Global growth challenges, a stronger dollar and additional monetary policy easing by central banks around the world have placed the Fed on the sidelines and pushed back forecasts for future rate hikes.
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216
Basic statistics Spread change Total return % Excess return %
Spread Yield Duration QTD YTD QTD YTD QTD YTD
1-3yr treasuries 0.00 0.75 1.89 - - 0.90 0.90 - -
1-3yr agencies 9.00 0.86 1.81 0.00 0.00 0.86 0.86 -0.01 -0.01
0-3yr MBS 34.00 1.55 2.42 16.00 16.00 0.56 0.56 -0.52 -0.52
1-3yr ABS 97.00 1.60 1.32 13.00 13.00 0.71 0.71 0.04 0.04
1-3yr IG corporates 108.00 1.83 1.94 0.00 0.00 1.22 1.22 0.24 0.24
3-5yr IG corporates 137.00 2.48 3.73 1.00 1.00 2.46 2.46 0.21 0.21
5-10yr IG corporates 177.00 3.36 6.40 -8.00 -8.00 4.15 4.15 0.14 0.14
1-5yr high yield 865.00 9.88 2.83 15.00 15.00 2.20 2.20 0.70 0.70
1-3yr corporates by rating
AAA 33.00 1.11 2.24 11.00 11.00 1.06 1.06 -0.05 -0.05
AA 58.00 1.32 1.96 2.00 2.00 1.11 1.11 0.11 0.11
A 86.00 1.60 1.94 5.00 5.00 1.08 1.08 0.09 0.09
BBB 163.00 2.40 1.93 -9.00 -9.00 1.46 1.46 0.51 0.51
1-3yr corporates by sector
Financial 110.00 1.83 1.92 14.00 14.00 0.96 0.96 0.00 0.00
Industrials 104.00 1.78 1.96 -12.00 -12.00 1.41 1.41 0.42 0.42
Utility/Energy 126.00 2.00 1.97 8.00 8.00 1.18 1.18 0.19 0.19
19
Fixed income returns Overview
Spread is based on option-adjusted spread. Duration is based on modified duration. Data as of March 31, 2016. Source: Bloomberg, BofA Merrill Lynch and SVB Asset Management.
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 20
Total return comparisons Positive quarter end
All returns above are on total return basis. YTD 2016 returns are on an annualized basis up to March 31, 2016. FI Credit refers to Barclays 1-3 year US Investment Grade Fixed Income portfolio; Treasury refers to Barclays 1-3 year US Treasury portfolio; Gold refers to S&P GSCI Gold Spot; WTI refers to Spot West Texas Intermediate Crude Oil; Wilshire refers to Wilshire 5000 Total Market Index; REIT refers to MSCI US REIT Index; S&P 500 refers to S&P 500 Index. Source: Thomson Reuters, Barclays Live and SVB Asset Management.
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Q1 2016
WTI 40.82%
REIT 34.18%
WTI 57.68%
US Treasury 6.67%
WTI 78.00%
Gold 29.67%
Gold 10.23%
REIT 16.47%
Wilshire 33.06%
REIT 28.24%
S&P 500 1.40%
Gold 16.50%
Gold 18.36%
Gold 22.95%
Gold 31.35%
Gold 5.53%
Wilshire 28.29%
REIT 26.97%
WTI 8.15%
Wilshire 16.05%
S&P 500 32.39%
S&P 500 13.69%
REIT 1.30%
REIT 5.90%
Wilshire 6.38%
S&P 500 15.79%
US Treasury 7.31%
FI Credit 0.30%
S&P 500 26.46%
Wilshire 17.18%
REIT 7.48%
S&P 500 16.00%
WTI 7.32%
Wilshire 12.70%
FI Credit 0.85%
S&P 500 1.30%
S&P 500 4.91%
Wilshire 15.78%
FI Credit 5.96%
S&P 500 -37.00%
REIT 26.27%
WTI 15.10%
S&P 500 2.11%
Gold 6.96%
FI Credit 1.45%
FI Credit 1.12%
Wilshire 0.70%
Wilshire 1.30%
FI Credit 1.89%
FI Credit 4.66%
Wilshire 5.61%
Wilshire -37.23%
Gold 23.96%
S&P 500 15.06%
FI Credit 1.75%
FI Credit 3.69%
REIT 1.26%
US Treasury 0.63%
US Treasury 0.56%
FI Credit 1.14%
US Treasury 1.62%
US Treasury 3.93%
S&P 500 5.49%
REIT -39.05%
FI Credit 11.59%
FI Credit 4.15%
US Treasury 1.55%
US Treasury 0.43%
US Treasury 0.36%
Gold -1.51%
US Gold -10.50%
US Treasury 0.90%
WTI -0.34%
REIT -17.84%
WTI -53.52%
US Treasury 0.80%
US Treasury 2.40%
Wilshire 0.98%
WTI -7.08%
Gold -28.26%
WTI -45.76%
WTI -30.50%
WTI -0.50%
Ass
et c
lass
retu
rns
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 21
Sector returns Spread tightening
Source: Bloomberg, BoAML and SVB Asset Management. Data as of March 31, 2016.
0.06
0.28
0.09
-0.47
0.40
0.49
-0.13
0.22
0.25
0.38
0.11
0.22
0.56
0.34
0.56
0.76
0.66
0.13
0.49
0.74
0.50
0.43
0.75
1.36
0.50
0.42
1.04
0.71
0.73
0.64
0.94
0.92
0.60
0.83
0.66
0.49
0.60
1.15
0.80
0.81
0.56
0.71
0.84
0.89
0.90
0.90
0.91
0.93
0.98
1.02
1.05
1.14
1.15
1.17
1.22
1.25
1.25
1.28
1.29
1.55
-1.00 -0.50 0.00 0.50 1.00 1.50 2.00
MBS
ABS
Insurance
Services
US Agency
US Treasury
CMBS
Real estate
Banking
Telecommunications
Media
Financial services
Energy
Capital goods
Healthcare
Automotive
Technology
Utility
Consumer goods
Basic industry
Total return % YTD Income return % YTD Price return % YTD
U.S. treasury
U.S. agency
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216
While operating margins may have peaked, they remain well elevated and leverage is still near historic lows.
22
Credit cycle Corporate credit health remains resilient
S&P 500 Index fundamentals
20%
25%
30%
35%
40%
45%
7%
8%
9%
10%
11%
12%
13%
14%
15%
Operating Margin (LHS) Total Debt to Total Asset (RHS)
Source: Bloomberg.
Operating margin (LHS) Total debt to total asset (RHS)
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216
With the exception of energy, all sectors showed credit metrics holding largely steady sequentially over the previous quarter.
23
Credit cycle Corporate credit fundamentals hold steady
S&P 500 debt to EBITDA by sector
S&P 500 operating margin by sector
Source: Bloomberg, trailing 12-month.
0
5
10
15
20
25
Energy Materials Industrials Consumer Discretionary
Consumer Staples Health Care Financials Information Technology
Telecom Services Utilities
Debt to EBITDA as of 12/2015 Debt to EBITDA as of 3/2016
-15%
-5%
5%
15%
25%
Energy Materials Industrials Consumer Discretionary
Consumer Staples Health Care Financials Information Technology
Telecom Services Utilities
Operating Margin as of 12/2015 Operating Margin as of 3/2016
Consumer discretionary
Consumer staples Healthcare Information technology
Telecom services
Operating margin as of 12/2015 Operating margin as of 3/2016
Consumer staples Healthcare Information technology
Telecom services Consumer discretionary
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 25
Central banks Taking it easy
United States United Kingdom Eurozone China Japan
Central bank Federal Reserve Bank of England European Central Bank People's Bank of China Bank of Japan
Benchmark rate 0.25-0.50% 0.5% 0.0% 4.35% -0.1%
Current policy
Rate hikes ahead as inflation rises toward 2% target with stable employment.
EU referendum, low inflation preventing a 25 bps rate hike.
Cut refinancing rate, lowered deposit rate, expanded QE, new long-term loan facility.
Reserve ratio cut 50 bps, with no change to lending and deposit rates.
Lowered deposit rate 20 bps into negative territory; reiterated quantitative and qualitative easing.
Inflation
Unemployment 4.9% 5.1% 10.3% 4.0% 3.2%
Analysis Q2 rate hikes expected in 2016, as Fed normalizes monetary policy.
Rate hike unlikely until year end, as domestic consumption offset doubts from EU vote and pricing environment.
No additional rate cuts or new policies expected over near term.
Further rate and reserve ratio cuts ahead to meet 6.5% annual growth target.
Continued easing through 2016 if fiscal stimulus fails to generate faster inflation.
1.2%
0.0% 0.5% 1.0% 1.5% 2.0%
Stable
Easing
Easing
Easing
-0.20%
-0.20% 0.30% 0.80% 1.30% 1.80%
2.3%
0.0% 1.0% 2.0% 3.0%
Source: Federal Reserve, European Central Bank, Bank of England, The People’s Bank of China, Bank of Japan, Bloomberg, SVB Asset Management.
Rising
0.70%
0.00% 1.00% 2.00%
1.0%
0.0% 0.5% 1.0% 1.5% 2.0%
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 26
China Precautionary evacuation Yuan weakens Nonperforming loans
Estimated capital flow The People’s Bank of China (PBOC) has increased the devaluation of the yuan since August 2015, as it responds to rising U.S. interest rates and attempts to reduce differences in the onshore/offshore rate. Capital outflows intensified in 2015 and continued into 2016, as investors see the yuan falling further. Concerns over nonperforming loans piling up in China’s banks contributed to jittery global capital markets during 2016’s first quarter. Anxiety over bank health will be unabated, as loan defaults should continue to rise through the year.
Source: The People’s Bank of China, Bloomberg, SVB Asset Management. * Through February 2016
6 6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9
US
D/C
NY
0.8 0.9
1 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8
NP
L, a
s %
of t
otal
loan
s
-$1,000
-$800
-$600
-$400
-$200
$0
$200
$400 B
B
B
B
B
B
B
B
1.8% 1.7% 1.6% 1.5% 1.4% 1.3% 1.2% 1.1% 1.0% 0.9% 0.8%
6.9 6.8 6.7 6.6 6.5 6.4 6.3 6.2 6.1 6.0
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 27
Developed economies Domestic consumption key UK retail sales Eurozone current account
Sweden GDP Robust domestic consumption better positioned some developed economies over others. UK retail sales remain firm, helping the British economy expand at a moderate pace with a steady labor market and positive wage growth. Public spending and retail sales above 3 percent for the past 12 months have contributed to accelerated GDP growth in Sweden. Consumption remains underwhelming in Europe, as exports outpace import. The resulting current account surplus has been a drag on Euro devaluation, helping to keep inflation low.
Source: UK Office For National Statistics, Statistics Sweden, European Central Bank, Bloomberg, SVB Asset Management.
-2 -1 0 1 2 3 4 5 6 7 8
% C
hang
e, Y
ear o
ver Y
ear
-10 -5 0 5
10 15 20 25 30
-1
0
1
2
3
4
5
% C
hang
e, Y
ear o
ver Y
ear
Cha
nge,
yea
r ove
r yea
r C
hang
e, y
ear o
ver y
ear
8% 7% 6% 5% 4% 3% 2% 1% 0%
-1% -2%
€30B €25B €20B
€15B
€10B
€5B €0B
-€5B
-€10B
5%
4%
3%
2%
1%
0%
-1%
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 28
Emerging economies South America Middle East
Africa The International Monetary Fund projects positive gross domestic product expansion across many emerging economies. Low commodity prices, political strife and security challenges represent primary risks to the pace of growth. Technology, consumer goods, infrastructure and financial services are sectors positioned for increased investment. Idiosyncratic events will keep the pace of near-term growth erratic in some emerging economies, though they remain the foundation for global growth over the long term.
Source: International Monetary Fund, Bloomberg, SVB Asset Management.
-8 -6 -4 -2 0 2 4 6 8
10
Cha
nge,
Yea
r Ove
r Yea
r
Iran Israel Saudi Arabia UAE
0
2
4
6
8
10
Cha
nge,
Yea
r Ove
r Yea
r
Nigeria South Africa Egypt Kenya
10%
8%
6%
4%
2%
0%
10% 8% 6% 4% 2% 0%
-2% -4% -6% -8% -6
-1
4
9
14
% C
hang
e, y
ear o
ver y
ear
Brazil Argentina Chile Peru
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 30
Portfolio strategy Macro overview
Source: SVB Asset Management and Bloomberg. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.
Economy
Rates
Duration
Sector
Solid data
• Q4 2015 GDP +1.4 percent. 2015 year-over-year +2 percent.
• Labor market averaged 200,000 new jobs in Q1, 4.9 percent unemployment rate.
• Inflation rising towards Fed targeted level.
Flat yield curve
• 18-month treasuries yielding 0.69 percent, 24-month treasuries yielding 0.72 percent.
• 2-year Treasury traded below 1 percent for majority of Q1 and ended March at 0.72 percent.
Defensive
• Short and intermediate benchmarks: Long duration vs. benchmark as coupon income should offset price volatility.
• Intermediate plus benchmarks: Stay neutral to benchmark.
• Long benchmarks: Shorter to manage price fluctuations.
Overweight spread product
• Favor corporate bond, commercial paper and asset-backed securities. Diversify by security type, sector and issuer concentration.
• As rates rise spread product will help protect bond prices due to higher income accruals.
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216
0.23%
0.40%
0.56% 0.60%
0.69% 0.72% 0.78%
0.86%
0.00%
0.10%
0.20%
0.30%
0.40%
0.50%
0.60%
0.70%
0.80%
0.90%
31
Portfolio strategy Relative value curve analysis
Source: SVB Asset Management and Bloomberg. Data as of 3/31/2016. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.
Yield curve
Due to the flat yield curve, we are not purchasing past 18-months. ê 2-yr yield pickup has averaged +3 to +9 basis points since end of January while 2.5yr has averaged +3 to +6 = flat! ê 6- and 9-month part of the curve has the most current pickup at +0.16. ê With the recent dovish commentary from the Fed, we anticipate low yields and a continued flat curve in Q2.
Bond
Yield
Yield pickup from shorter tenure
3-month T-bill 0.23% ----
6-month T-bill 0.40% 0.16
9-month T-bill 0.56% 0.16
1-year Tsy 0.60% 0.04
1.5-year Tsy 0.69% 0.09
2-year Tsy 0.72% 0.03
2.5-year Tsy 0.78% 0.06
3-year Tsy 0.86% 0.07
Flat
Flat
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216
Strategy Duration target
Short duration benchmark 3-month and 3-6 month
Intermediate duration benchmark 6-month
Intermediate plus duration benchmark 9-month
Long duration benchmark 1- and 2+ years
32
Portfolio strategy Duration and sector overview
Source: SVB Asset Management. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.
Sector Overview
Government
Favor Treasuries over Agencies for liquidity purposes and the reduced spread pick of agencies.
Corporate bonds
Favor corporate bond and commercial paper. Diversify by security type, sector, sub-sector and issuer concentration.
ABS
Strong consumer credit fundamentals and stable spreads in auto and credit card receivables make this a sought-after sector.
-30% Neutral +30%
-30% Neutral +30%
-30% Neutral +30%
Neutral -30% +30%
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 34
Money market funds A brief history
Source: SIFMA, Barclays Live and SVB Asset Management.
1970 1980 1994 2001 2008 2010 2014 2016
First MMF created
SEC 2A-7 rules created
First fund to “break the buck”
$2T industry
Reserve Fund “broke the buck”
MMF reform
Announced additional set of MMF reforms
October implementation of 2014 reforms
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
Trill
ions
MMF Total Prime Government Treasury Tax Exempt
Total money market fund assets continued their recent rise, increasing by 8 percent by end of February 2016 compared to April 2015.
35
Money market funds Assets on the rise
Money market funds AUM trend
Source: Crane Data.
MMF total Tax exempt
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216
In July 2014 the Securities and Exchange Commission (SEC) approved substantial changes to the rules governing money market funds in an effort to strengthen the industry against the risk of runs
Three key reforms are scheduled to take effect in October 2016: – Institutional prime and municipal MMFs must float their market-based net asset value (NAV) by executing trades based on the current market values of
the securities in their portfolios, rounded to the fourth decimal place – The MMF board of trustees may impose a liquidity fee, up to 2 percent, if the fund’s weekly liquidity assets fall below 30 percent of total assets if they
deem it to be in the best interest of the fund – The MMF board of trustees may impose a redemption gate if the fund’s weekly liquidity assets fall below 30 percent of total assets and it deems such a
move to be in the best interest of the fund
Government and Treasury MMFs are not subject to the floating NAV or fee and gate provisions*
The SEC also implemented additional reporting and disclosure requirements for the MMF industry
Treasury and IRS issued tax guidance for floating money funds, with alternative methods for calculating gains/losses
36
2014 Key reforms summary
*A government or Treasury fund may opt into the fee or gate provisions, but most fund companies including all of SVB’s fund partners have publicly stated they will not do so
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216
These three reforms, which specifically impact institutional prime and muni funds, will be the most disruptive to investors who use these funds:
37
Money market fund Three key reforms
Floating net asset value • The value of prime fund holdings may fluctuate up or down on any given day
• Investors will need to track and account for small capital gains or losses
Liquidity fee • During severe market conditions, the fund’s board may impose a liquidity fee
• Investors would pay up to a 2% fee for immediate access to their funds
Redemption gates • During severe market conditions, the fund’s board may impose a redemption gate
• Would result in investors’ inability to access funds for up to 10 days
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216
MMF reforms have implications for corporate treasury groups in a number of areas including:
38
Money market fund Implications
• Many corporations would be excluded from continuing to invest in MMFs altogether, simply based on existing policy language that permits investment only in stable NAV funds
• The section of investment policies governing MMFs must be modified to reflect potential realized and unrealized gains and losses from a floating NAV
• Investment policies would need to define acceptable NAV fluctuation and outline required actions in the event an NAV drops below the threshold value
Investment policies
• Floating NAV and the potential for fees and gates complicate the straightforward method by which MMF sweep purchases and redemptions are tracked today
• A control used to identify small gains and losses on daily, automatic sweep transactions would need to be developed
• Procedures would need to be created and supporting systems would need to be reengineered to deal with a liquidity fee or redemption gate notification
Procedures and systems
• Floating NAV will not preclude shareholders from classifying their investments in money market funds as cash equivalents, under normal circumstances
• Investors may use a simplified method of calculating MMF gains or losses
• The short-term gain or loss equals the changes in share value plus the net investments (including reinvested dividends) over a computational period rather than each transaction
• Investors in floating NAV MMFs will not be affected by wash sale rules
Accounting and tax reporting
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 39
Money market fund update Industry response Money market funds AUM trend
In anticipation of reforms that will fundamentally change the way in which money market funds, in particular the prime funds, operate, a significant number of prime funds have converted to government funds in order to avoid having to implement the new regulatory requirements. As of March 1, 2016, $272 billion of prime money market funds have declared
conversion to government funds, with $172 billion having completed the conversion. With government fund assets rising steadily over the past few months, prime fund
assets have been eclipsed by government funds (both institutional and retail, including treasury funds) for the first time in the industry’s history. This has coincided with a rise in yield of both government and prime funds.
Prime funds have also reduced weighted average maturity to stay nimble ahead of the reform implementation.
Money market funds historical yields Institutional prime MMF historical WAM
700 800 900
1,000 1,100 1,200 1,300 1,400 1,500
Trill
ions
Prime Treasury & Govt
0.00%
0.05%
0.10%
0.15%
0.20%
0.25%
0.30%
Institutional Govt Institutional Prime
20
30
40
50
Day
s
Source: Crane Data.
Treasury and govt
Institutional govt Institutional prime
SVB Asset Management | Quarterly Economic Report Q1 2016 0416-0041GUEX1216 40
Drill down Floating NAV
Source: Crane Data.
Market-based NAVs fluctuate for a variety of reasons Historical data suggests a range of +0.0002 to 0.0001. Fluctuations in the market-based NAV (MNAV), above or below $1.0000, can be common but have typically been small.
These fluctuations can occur as the result of changes in market interest rates, changes in credit spreads, inflows and outflows of money, and ratings downgrades or defaults on securities held in the portfolio.
Despite the small anticipated nature of these NAV fluctuations, investors will still need to track and account for them.
Crane Prime Institutional Money Fund Index Historical MNAV
SVB Asset Management | Quarterly Economic Report Q1 2016
Portfolio Management Team
Eric Souza [email protected] Paula Solanes [email protected] Renuka Kumar, CFA [email protected] Jose Sevilla [email protected] Hiroshi Ikemoto [email protected] Jason Graveley [email protected]
President, SVB Asset Management
Lauri Moss [email protected]
Head of Investment Strategy and Portfolio Management
Ninh Chung [email protected]
Head of Credit Research
Melina Hadiwono, CFA [email protected]
Credit and Risk
Tim Lee, CFA [email protected] Daeyoung Choi, CFA [email protected] Nilani Murthy [email protected]
Silicon Valley Bank Partners
Teresa Quizon [email protected]
41
Our team
SVB Asset Management | Quarterly Economic Report Q1 2016
This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice, nor is it to be relied on in making an investment or other decision. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.
All material presented, unless specifically indicated otherwise, is under copyright to SVB Asset Management and its affiliates and is for informational purposes only. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party without the prior express written permission of SVB Asset Management. All trademarks, service marks and logos used in this material are trademarks or service marks or registered trademarks of SVB Financial Group or one of its affiliates or other entities. ©2016 SVB Financial Group. All rights reserved. Silicon Valley Bank is a member of the FDIC and the Federal Reserve System. Silicon Valley Bank is the California bank subsidiary of SVB Financial Group (Nasdaq: SIVB). SVB, SVB FINANCIAL GROUP, SILICON VALLEY BANK, MAKE NEXT HAPPEN NOW and the chevron device are trademarks of SVB Financial Group, used under license. B_SAM-16-14770 Rev 05-10-16.
SVB Asset Management, a registered investment advisor, is a non-bank affiliate of Silicon Valley Bank and member of SVB Financial Group. Products offered by SVB Asset Management:
42
Are not insured by the FDIC or any other federal government
agency
Are not deposits of or guaranteed by a bank
May lose value
SVB Asset Management | Quarterly Economic Report Q1 2016